September 2021 Market Commentary
Markets sold off in September, buffeted by a number of issues including slowing economic and corporate earnings growth, inflation, interest rates, China, and concerns about the debt ceiling and a government shutdown. For the month, the S&P 500 fell 4.8%, its worst performance since March 2020. While it would be too easy to describe the poor performance as a self-fulfilling prophecy, it was consistent with the fact that historically, September is the worst calendar month of the year for the S&P 500. Other asset classes fared little better as small caps (Russell 2000) fell 3.1% and international developed and emerging markets shed 3.2% and 4.3%, respectively.
In the US, economic data continued to point towards further expansion, albeit at a slowing rate. After growing 6.7% in the second quarter, the consensus forecast for third quarter GDP growth stands at 5.0%. Likewise, corporate earnings growth is also expected to decelerate, from 95% in the second quarter, to 28% in the third quarter. The slower growth is the result of a natural deceleration from the initial rebound following last year’s recession, reduced fiscal stimulus, the impact of coronavirus Delta variant, and supply chain issues.
As the past six months have shown, supply chains and inflation are inexorably linked. Economics 101 states that limited supply and strong demand results in higher prices. That has been borne out in recent months as manufacturers have struggled to meet exceedingly strong demand. At the outset of the year it was widely expected that supply chain issues and the surge in inflation would be temporary. Thus, at a time when both were supposed to be normalizing, recent headlines have raised doubts about those assumptions. In China, soaring coal prices have resulted in reduced electricity generation impacting numerous industries ahead of the all-important holiday shopping season. In the UK, a severe truck driver shortage has resulted in over 2,000 petrol stations closing for lack of fuel. And in the US, over 70 container ships sit offshore waiting to unload at the Port of Los Angeles reflecting strong consumer demand and a shortage of both trucks and drivers to move the freight to its final destination. Though recent inflation readings have pointed to a potential levelling off in price increases, policy makers, including the Fed, now expect both supply chain issues and thus higher inflation to persist into 2022.
In China, the government continued its crackdowns on various companies and sectors as President Xi strives to implement his vision of “common prosperity.” Ostensibly intended to address the country’s growing income gap, President Xi is also focused on reviving China’s socialist ideals and in doing so, “rejuvenating” the country. The crackdowns have challenged some of the country’s most successful tech companies and raised questions about how Xi will balance his desire for greater government control with innovation and economic growth. Already the government’s actions have cost investors hundreds of billions of dollars. Highlighting China’s slowing growth, Evergrande, the country’s second largest property developer saddled with over $300B in debt, effectively defaulted on its debt. Though unlikely to be a “Lehman” moment for the country, it nonetheless highlighted the risks associated with the country’s highly leveraged real estate market.
Towards the end of the month, political gridlock crept into the picture as Congress engaged in its now time- honored tradition of playing chicken with both the budget and debt ceiling. While a bipartisan deal to fund the government until early December was ultimately passed, thus far there has been little discernable action on raising the nation’s debt ceiling. Currently, the US Treasury expects the government to be unable to service its debts after October 18, the effects of which US Treasury Secretary Janet Yellen has described as “catastrophic”, and arguably would have far greater consequences than a government shutdown. While the general expectation is that Congress will ultimately pass an increase, it may not happen before additional market volatility forces the issues.
Like equity markets, fixed income returns for the month were negative, with the Bloomberg Aggregate bond index, the broadest measure of the US bond market, losing 0.9%. Only high yield, driven by the riskiest parts of the market, managed to eke out a small positive return. For much of the month, fixed income markets were quite stable with interest rates (10-Year Treasury yield) trading in a narrow range of just nine basis points. However, following the conclusion of the Fed’s September meeting on the 22nd, rates surged. The move higher was widely attributed to “hawkish” comments by Fed Chair Jay Powell who signaled that the central bank is close to beginning tapering. In addition, other central banks also appear poised to tighten monetary policy. The Bank of England surprised markets by raising the prospect of increasing rates as soon as November, while Norway delivered the first post-crisis hike.
These hawkish developments come as inflation, though moderating, remains stubbornly high and the duration of supply chain issues continues to be prolonged. The fear is that the longer supply-chain issues linger,the more some of those price increases will become permanent. Though that isn’t a certainty, the market is pricing in a higher likelihood. Other factors contributing to the recent rise in rates include energy shortages leading to higher oil and natural gas prices, and the debt-ceiling impasse currently playing out in Congress. As a counterpoint to the market’s inflationary worries, both Fed Chair Powell and European Central Bank President Christine Lagarde, have cautioned recently that there are no signs that higher inflation is becoming broad-based across the economies, continuing to insist that all-signs still support the transitory inflation mantra.
For the month, the 10-Year Treasury yield increased 0.18% to end at 1.49%, the highest monthly close since May. In munis, 10-Year yields on AAA municipal bonds rose 0.20% to end at 1.12%, the highest level since mid-March. While the rise in rates impacted current bondholders, it is a positive for reinvestment opportunities after muni yields spent the better part of the past year at all-time lows.